Determining a “buy” or “sell” entails understanding some factors that move the market, and there are plenty of ways to analyze them. In this series, CapitalWatch is looking at two key ways analysts and traders decide on an investment – by evaluating the intrinsic value of a stock and by assessing the trends.
Fundamental analysis studies the factors that can impact a security’s value to arrive at its “fair market” price. These would be both macro and micro factors including the coronavirus, the tariff war, crude oil inventories, the slump of China’s auto market, the company’s financials, dividend yield, the size of its R&D team, and the management’s leadership skills. An analyst deems a stock undervalued if its fair market value is higher than its real value and it gets a “buy” rating.
Thus, China’s top e-commerce and tech giant, Alibaba Group (NYSE: BABA; HKEX: 9988), last traded at $189 per American depositary share after-hours on Friday, but has a consensus rating of “buy” and an average price target of 27.6% upside, at $240.55 per ADS. That’s based on ratings issued by 24 Wall Street analysts over the past 12 months for a long-term period, as surveyed by market data platform MarketBeat. The latest action was the lowering of the PT on BABA from $260 to $248 per share, still an “overweight,” by Hans Chung of KeyBanc Capital.
On the other hand, we have the statistical trends of supply and demand for assets – which a technical analyst considers when making a trade. This method evaluates past trading activity, the price and volume of a security, the speed of the price change, and investors’ behavior, and is used by traders who seek to benefit from short-term pattern fluctuations. Stock charts show such indicators, which include past highs (resistance) and lows (support), moving averages, and peak and bottom levels. For example, when analyzing a chart, one question to consider is – is the stock shifting higher toward the resistance point, which could mean a “sell”? Volume is another key indicator in the technical method – unusual trading volume could lead to either a down or an up movement.
(Alibaba BABA Stock Chart / Source: MarketBeat)
To sum up, fundamental analysis relies on the concept that a company’s stock has an intrinsic value, which stockholders will recognize in time, while technical analysis relies on the repeat pattern of stock and does not take into account a company’s condition.
While most investment firms these days use algorithms that combine fundamental and technical factors, some of the best investors have been avid followers of one of the two methods. Warren Buffett, for example, is a major value investment advocate. As CNBC wrote, Buffett could buy a company entirely if he saw long-term growth potential and its securities were at too significant a discount to their intrinsic value.
Meanwhile, the technical analysis investing style is attributed to Charles Dow, founder of the Wall Street Journal and creator of the Dow Jones Industrial Index. The method was used and improved by acclaimed market forecasters William P. Hamilton, Robert Rhea, Edson Gould, and John Magee.
"For individual stock selection, we clearly prefer fundamental analysis with a particular focus on balance sheet quality, high capital returns, structural growth, strong earnings trends, and reasonable valuation multiples. Fundamental analysis is usually very time-consuming," an investment professional at QuantTrend, a UAE-based investment firm, wrote to CapitalWatch on Saturday. He also said, "A quantitative approach considerably increases fundamental analysis capabilities and results in a systematic and repeatable process."
Donovan Jones, CW columnist and the founder of VentureDeal, said, “I generally prefer fundamental analysis and believe it is more suited to medium- and longer-term investors, whereas technical analysis may be more suited to short-term, or day traders.”
To note, each of the abovementioned methods has many aspects and indicators to take into account when making an educated investment. Learning more about each can help in building your own investment philosophy.